Is you tax preparer giving you tax planning advice? For that matter is your financial advisor giving … [+]
Many people confuse filing their taxes with doing tax planning. These are two very different services; ignoring this fact can cause you to be forced to leave the IRS a huge tip. Each year, around April 15, millions of Americans are forced to file their taxes; there is literally a deadline and penalties for not filing in a timely manner. However, no such deadlines or direct penalties exist for not doing proactive tax planning. That being said, the costs of not at least exploring the tax strategies available to you can be devastating for your financial security.
Is My Tax Preparer A Tax Planner?
Think of tax preparation as documenting history. Your tax preparer consolidates your various tax forms and tax deductions into a document to report what happened tax-wise in your life during the tax year.
Tax planning is looking ahead at what you can do to minimize your taxes in the future. A few tax-planning strategies could help lower your taxes for a tax year that has already passed, but their benefits may be limited if they have not begun during the tax year. For example, you can still make some retirement plan contributions after the tax year has ended, but they must be made before you file your taxes. However, smaller contribution limits may limit your tax savings if your retirement plan was not optimized during the tax year.
Tax planning happens year-round and involves proactive strategies to control how much you must pay each year. If you only speak with your tax person once a year when filing your taxes, they likely are not offering much tax-planning guidance.
What Exactly Is Tax Preparation?
Simply put, tax preparation is preparing and filing a tax return. Some people will rely on software like TurboTax to file their own tax returns. Others with bigger tax liability will generally work with a CPA or an enrolled agent (EA) to help with all of the complicated tax forms that can go into filing your taxes each year.
Sometimes, your tax person may give you some tips to lower your taxes in the future, such as increasing your 401(k) contributions or donating more to charity. They may even suggest opening up some type of retirement plan for the self-employed. Most of these tips fall short of in-depth tax planning. It is not uncommon for people to leave these discussions without really understanding how much benefit they may/may not get from these tax-planning tips.
What Does Tax Planning Entail?
First off, tax planning is not about getting the biggest tax refund each year. Likewise, getting a huge refund doesn’t mean your tax person is amazing. Similarly, owing money on your taxes doesn’t mean your tax preparer isn’t doing their job well.
Real tax planning is separate from just filing your taxes. Individuals and business owners can both benefit from proactive tax planning. These services are typically performed by a CPA, enrolled agent (EA), business manager or tax-planning-focused CFP® with in-depth experience and knowledge of tax law rather than a tax preparer. Several of these people may work together on your overall tax plan, especially for business owners.
A few common examples of tax-planning strategies include bunching deductible expenses (e.g., medical) to avoid being wiped out by the standard deduction. Tax-loss harvesting to minimize the tax drag on your various investments. Optimizing retirement plan contributions to reduce your expected lifetime tax bill. You may also receive guidance on the best timing for capital expenditures to reap the tax’s largest benefits. There are many more tax-planning strategies that you may benefit from. I just wanted to share a few that could help the average taxpayer.
Can My Financial Advisor Really Not Give Me Tax-Planning Guidance?
You may have seen a disclosure from your financial advisor that reads, “This is not tax advice.” If you have, this likely means your advisor works at a firm that does not allow its employees to offer tax-planning advice to its clients.
Sometimes, tax planning may just be helping you keep better books to avoid missing out on valuable tax deductions that you forgot about. It is easy to do, especially for businesses and high-income-earning business owners. Other strategies are more complicated and may require help from your CPA, financial planners and tax attorney.
Other tax strategies counterintuitively may raise your taxes today but save you money over time, such as Roth IRA contributions or Roth conversions. These strategies may have you pay more taxes this year to increase your tax-free income in the future. Who doesn’t love tax-free income?
You Deserve Expert Tax-Planning Advice
As you seek proactive financial advice, you should expect more when it comes to the tax-planning guidance you receive. The days of your financial advisor helping you put some money into your IRA and calling it tax planning are over. Let’s be honest; most of you reading this likely earn too much money to deduct your IRA contributions. So, we are likely talking about contributing more to your 401(k) or Defined Benefit Plan. If your financial advisor isn’t paid to offer advice on your retirement plan, they may be less motivated to hold you accountable for making appropriate contributions each year.
As a fiduciary financial planner who specializes in working with high-income-earning business owners, many retirement plan contributions are motivated by their tax savings beyond just what is needed to retire comfortably at some point in the future. With a well-designed Cash Balance Pension Plan, you could shelter hundreds of thousands of dollars of income from taxation each year.
Last year, I designed a retirement plan that would allow a business owner to shelter over $700,000 in income from taxes across his family. That would save him over $3.5 million in taxes in California over the next decade. His CPA (who referred him to me) has been telling him to set up a plan like this for years, but he was too busy and just never got around to it. How much would you need to work to net an extra $3.5 million?
I know we are all busy and hate thinking about financial things. But the cost of ignoring tax planning grows as your income does. Make sure you aren’t paying more taxes than you are legally obligated to pay. Minimizing your taxes today can help you reach financial freedom much more pleasantly.
Reminder: It isn’t how much you earn that matters; it is how much you keep.
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